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Lower-than-expected results were affected by reduced new brokerage accounts with slump in total daily average revenue trades (DARTs). In addition, increase in operating expenses acted as a headwind for the company in the ongoing challenging macro-economic environment. Yet, improved revenue with total loan portfolio contractions were the positives for the quarter.

E*TRADE reported third-quarter net loss of $28.6 million against net income of $39.5 million in the prior quarter.

The DARTs for the reported quarter decreased 7% sequentially to 129,000. Net new brokerage assets reported were $1.9 billion, significantly down from $2.2 billion in the prior quarter.

At the end of the quarter, E*TRADE reported 4.4 million customer accounts, including 2.9 million brokerage accounts. Net new brokerage accounts of 18,000 dipped considerably from the prior quarter’s level of 46,000.

Net operating interest income plummeted 6.5% sequentially to $260.9 million in the quarter under review. The decline was due to lower interest income, though partially offset by reduced interest expenses. Net interest spread in the quarter was 2.28%, down from 2.44% in the last quarter.

However, non-interest income improved to $229.2 million, up 32.3% sequentially. The elevation compared to the prior quarter was due to increased net gains on loans and securities and high fees and service charges, though partially offset by decreased commissions.

Total operating expense moved up 2.7% sequentially to $289.0 million. The upsurge was primarily attributable to higher professional services, increased compensation and benefits expenses and elevated other operating expenses. These expenses were partially offset by lower advertising and market development costs.

Credit Quality

Overall credit quality was mixed during the quarter, affected by newly identified bankruptcy filings. E*TRADE's provision for loan losses more than doubled to $141.0 million on a sequential basis. Net charge-offs also surged 31.3% sequentially to $158.5 million. However, allowance for loan losses decreased 3.3% sequentially to $508.3 million.

E*TRADE reduced its balance sheet risk further. The company’s loan portfolio was $11.1 billion at the end of the reported quarter, down by $616 million from the prior quarter, mainly related to $458 million of paydowns.

The company maintained bank capital ratios well above the regulatory well-capitalized threshold. As of September 30, 2012, E*TRADE reported Tier 1 common ratio of 10.9%, up from 10.2% in the prior quarter and 9.3% in the year-ago quarter.

Total risk-based capital ratio was 19.3%, up from 18.0% in the prior quarter and 17.2% in the prior-year quarter. Tier 1 leverage ratio was 7.9%, in line with the last quarter though down from 8.1% in the prior-year quarter.

Performance by Peer

Among E*TRADE’s peers, Charles Schwab Corporation’s (SCHW - Free Report) third-quarter 2012 earnings of 19 cents per share were marginally ahead of the Zacks Consensus Estimate of 17 cents. Also, this compares favorably with the year-ago quarter’s earnings of 18 cents. The results in the reported quarter also included a non-recurring state tax benefit of about $20 million.

Improved asset management and administration fees as well as balance sheet restructuring actions were the positives for the quarter. Yet, higher operating expenses and provision for loan losses as well as a fall in net interest income and trading revenue partially dented the results.

Our Viewpoint

The competitive position in the market for brokerage business depends on trading customers, predominantly active traders. As the long-term investing customer group is less developed, compared with the trading customers, there is an opportunity for future growth as and when the long-term customers expand.

Development of innovative online trading and long-term investing products and services, delivery of advanced customer service, creative and cost-effective marketing and sales, and expense discipline can be considered as the key factors in executing E*TRADE’s strategy to profitably expand trading and investing business.

Further, E*TRADE’s initiatives to reduce balance sheet risk appear to be promising, although, it will put near-term pressure on the net interest margin. The company’s capital position and improving delinquency trends are impressive. Yet, amid challenging economy, reducing DARTs and new brokerage accounts remain a matter of concern.

E*TRADE currently retains a Zacks #3 Rank, which translates into a short-term Hold rating. Considering the fundamentals, we also maintain our long-term ‘Neutral’ recommendation on the stock.

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